Beta hedging with options?
How do you beta hedge with two options that have different underliers? In other words, how would one reproduct a typical long/short pair-trade with options?
Let's say you are going to buy AAPL 1month Calls 5% OTM, and you want to hedge it by buying SPY's puts: How would you think about the appropriate strike px for the puts? How would youadjust for the different volatility of both underliers, and what are other considerations that should be thought about?
First, think of what is the general view you are making. It's "Apple will outperform S&P", right? However, the exact nature of that view will determine how you want to structure the trade, since by trading options you are adding a dimension.
If you are forecasting that AAPL is going to outperform the index on the way up, then you can create a conditional spread by buying a call on AAPL and selling a call on the index to finance is. In that case you can use some form of break-even logic and your thinking would be something like "I am long Apple which has a beta of 1.2 to Nasdaq, so if I sell 1.2 units of NDX options, what moneyness can I get?"
Alternatively, you can be saying If you are like to be long AAPL but you don't like to be long the market. In that case, you just buy an Apple call and sell the futures against it's delta (i.e. delta * beta). Buying puts against your calls kinda doubles up on that view, so it's not necessary.
Finally, buying a call on one and a put on the other expresses a view that you think Apple will be outperforming the market rain or shine, but want to have some convexity to play it. A a collateral view, you think both market and street vol is cheap (really?). In that case, you probably want to put on the initial structure delta*beta neutral but do not adjust your deltas as they change.
Re-reading my scribbles makes me think that (a) I should have taken an English writing class when I had the chance and (b) I should be on Adderall to avoid making careless mistakes
Thanks for your help. A few questions... 1. Is it necessary to have to take a view on the way that AAPL will outperform the NDX up to the expiry date? -- can we instead just have a view on where these two will be at whatever expiration date? (Does that default to mean that generally, we would expect APPL to outperform the NDX up to the expiry?)
Thanks for your help
Vel non quam quia cupiditate minima vero. Voluptas harum a saepe illo. Veniam qui neque modi.
Et numquam iste velit consequatur corporis quo. Est optio laudantium ipsa libero nobis fuga. Ipsam blanditiis repudiandae laborum culpa.
Distinctio et voluptate praesentium minima perferendis libero. Nam minima dolorem eos quis laudantium ipsa animi ipsum.
See All Comments - 100% Free
WSO depends on everyone being able to pitch in when they know something. Unlock with your email and get bonus: 6 financial modeling lessons free ($199 value)
or Unlock with your social account...